If you're invested in cryptocurrencies, it's hard not to think about the red ink in your wallet as worries about Federal Reserve interest rate hikes have sent token prices plummeting.
But if you want to think about the long-term outlook, look not at your "DeFi" holdings, but at your "TradFi" portfolio of stocks and bonds. While the losses there have not been as brutal as those in cryptocurrencies, those markets are crashing too, and to such an extent that at some point there will be a political reaction that will affect cryptocurrencies as well.
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The Federal Reserve (Fed) is currently in aggressive mode as it is determined to nip inflation in the bud. However, it's easy to imagine the central bank hitting the brakes again once Wall Street's pain spills over into the normal economy - which it almost certainly will - and if that leads to political turmoil - which it almost certainly will. After that, the economic circumstances in the post-coronavirus pandemic world could quickly become so catastrophic that the Fed and other central banks, in the absence of other possible solutions, will return to the same policy framework of the last decade and a half, with interest rates near zero and quantitative easing (QE) as the norm. And that will be the basis for a cryptocurrency resurgence.
The complicating factor is what this could mean for the Fed's reputation. If it returns so quickly to a policy solution that has led to wild distortions and contributed to the inflation problems of the past year, could that show that our entire monetary system is broken? Could this finally be the moment when people realize we need a new model?
After so many false starts, I hesitate to declare that the next cycle is the one in which crypto and Web 3 technologies and ideas rise above the fashionable ways in which mainstream investors and companies otherwise tend to engage with them, and instead become more integrated into the global economy. However, I think that a dynamic in which central banks feel compelled to provide "helicopter money" could have a "Emperor's New Clothes" effect, with people questioning the prevailing financial paradigm and looking for alternatives.
Broken government = broken money
Before we take a look at what lies ahead, let's turn back the clock 14 years to address the real problem.
After the 2008 financial crisis, it became clear in the U.S. that monetary policy was the only lever to stimulate economic growth due to the failure of the federal government. That dependence is arguably even more pronounced today.
It was not always the case. In the 1930s, the solution to the Depression was the implementation of massive government-funded public works projects and the creation of social security for the unemployed. This eventually led to an economic boom and created an infrastructural base on which the great expansion of the U.S. economy in the 20th century was built.
Century was built upon. But in 2009 and beyond, the Obama administration faced a Republican-controlled Congress. The two sides sought bipartisan agreement to support tax spending projects against all odds, but aside from the controversial trillion-dollar bailout programs that saved Wall Street from collapse, nothing substantial was ever passed to address the needs of the American people. The stimulus initiatives were piecemeal and politicized, and ultimately insufficient to give the U.S. economy the growth it needed.
This was a deeper problem than most people realized. It directly challenged confidence in the democratic process, which is supposed to be the mechanism by which public funds are allocated to serve a common national interest.
Libertarians, of whom there are many in the crypto community, might argue that the best thing government could do would be to get out of the way. But their idealism tends to ignore the pre-existing market distortions created by Wall Street's politically privileged position in the economy - a privilege most evident during the housing bubble that preceded the crisis. So "getting out of the way" was in itself a unilateral measure. The U.S. banks got their bailouts, but everyone else got crumbs.
The consequence of our politicians shirking their responsibilities in this regard was that the burden of stimulating an ailing economy fell on the Fed, which was forced to cut interest rates so aggressively that it quickly reached the so-called zero bound. With no more room to cut rates beyond zero percent, quantitative easing (QE) became the solution. Buying bonds, and later other financial instruments, was a way to keep borrowing rates low for companies financing themselves in the capital markets.
Trillions of dollars of monetary expansion kept things moving, but also proved to be a brutally blunt instrument. Savers were hurt, borrowers were helped. Hedge funds and other institutional owners of stocks, bonds and other financial instruments made profits like bandits, while tens of millions of people struggled to keep their heads above water.
Nonetheless, QE became the default option whenever times got even a little tougher, which was the case during the pandemic. The Federal Reserve introduced what it called "Infinity QE," an unlimited commitment to keep buying assets to keep interest rates low. Combined with the supply and demand distortions caused by the economic disruptions of the pandemic, this was a recipe for the runaway inflation that eventually occurred.
So what now?
Fast forward to 2022. The political rifts are arguably even wider than they were in the Obama era. And confidence in government to solve our economic challenges is at an all-time low.
So what happens when this year's financial crisis leads to an inevitable decline in financing for everything from startups to homes? Growth will slow dramatically and jobs will be lost. And while this drop in demand should help stop inflation, there is a legitimate fear that the supply chain problems caused by COVID will lead to further shortages and price increases.
It is hard to believe that Congress will agree to an aggressive stimulus program to address this problem. As the midterm elections approach and the problem becomes more politicized, the pressure will grow on the Fed to act.
But then what? The effectiveness of monetary policy depends on confidence in the overarching system - that people trust the Fed to protect the value of the dollar even as it increases the money supply. It is not clear that this confidence will endure after such an about-face.
In other words, the failure of the overarching system at large will become obvious. And this is precisely where Bitcoin and blockchain solutions represent the alternative.